Economy still hobbled by weak housing, high debts

Commentary: Middle-class families under pressure

WASHINGTON (MarketWatch) – The weak housing market and high levels of household debt are still holding back the economic recovery, more than four years after the start of the recession and nearly seven years after the housing bubble began to deflate.

Make no mistake, the economy is growing. Over the past 10 quarters, the economy has grown at a 2.4% annual pace, exactly the pace it grew in the 10 quarters before the recession hit.

That kind of growth isn’t too shabby… in normal times. But when you have 13 million unemployed Americans (plus millions more who would like a job), it’s unacceptably slow.

American families have made progress in reducing their debt load, but we’re still have far more debt that we had 20 or 30 years ago.

Typically, construction of new homes and home sales helps pull the economy out of a recession. For instance, after the 1970, 1975 and 1982 recessions, residential investments added about 1 percentage point a year to growth during the first years of recovery. But because the housing market is still depressed, it can’t fulfill its typical role this time around. Residential investments have subtracted from growth in each of the past six years.

The other major source of growth early in recoveries has traditionally been the expansion of consumer debt to buy durables such as autos. But because many households are still trying to pay down their debts, the credit channel has been relatively impotent this time.

On Wednesday, Federal Reserve Chairman Ben Bernanke delivers his semiannual testimony on the state of the economy to Congress. Fed watchers and investors will be culling through his testimony for clues about whether the Fed will pull the trigger on further bond purchases, dubbed QE3 (the third go-around of quantitative easing).

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But whatever Bernanke says about QE3, underlying his testimony is a judgment that housing and consumer debt are still an anchor, dragging down our growth rate. At the latest meeting of the Federal Open Market Committee, Fed policy makers said the housing market remained “depressed.” In the glossary of Fed Speak, “depressed” is just about the worst thing one can say.

In January, the Fed released a white paper on housing, which concluded that, “looking forward, continued weakness in the housing market poses a significant barrier to a more vigorous economic recovery.”

There have been signs of life in housing. Housing starts have risen slightly, as have home sales. Builder confidence has improved markedly over the past few months. But activity and sentiment remain at very depressed levels.

And there’s one thing that’s still declining: Prices. Home prices have fallen 4% in the past year and are down about 33% from the peak, according to the Case-Shiller and the CoreLogic home price indexes. With prices still declining, more homeowners will lose whatever tiny bit of equity they have remaining in their home, adding to the millions who are already underwater. Some will lose their house completely to foreclosure or short-sale.

The amount of delinquent debt is far higher now than it was before the bubble burst. That means more foreclosures, bankruptcies and write-downs lie ahead.

Since the peak of the bubble in 2006, homeowners have lost more than half of their home equity — more than $7 trillion.

The decline in home values has really hurt the middle class, who are more likely to have the bulk of their wealth tied up in their home than poor people (who have no wealth) or rich people (who have most of their wealth in financial assets — go Dow 13,000!). The typical middle-class family has lost wealth equivalent to 70% of a year’s income.

Families have been reducing their debt burdens rapidly since the Panic of 2008. After growing 10% a year during the bubble years, household debt levels have actually declined by about 4% over the past four years. Although charge-offs have accounted for most of the decline in debt, households have also been actively deleveraging by about $200 billion a year, according to research by Benjamin Tal and Emanuella Enenajor of CIBC World Markets.

By some measures, the debt burden is back to normal levels. For instance, households have to pay just 11.1% of their after-tax income to service their debts, the lowest in 17 years and down from 14% at the height of the frenzy in 2007. Low interest rates, especially for mortgages, are really helping.

But by other measures, the deleveraging has a ways to go. Households have only reduced their debts from 127% of their after-tax income in 2007 to 111% in 2011. That’s progress, but it’s still far above the 90% or less that prevailed before the housing bubble.

Delinquencies and foreclosures are still elevated from pre-recession levels. It’s going to take a few more years to clear out the backlog of delayed foreclosures, which will keep home prices soft.

Most likely, it’ll take several more years before the housing market truly recovers, and American families have paid off enough debt to feel comfortable again. Until then, the recovery will remain hobbled.

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